Australia Tax: Australian Taxation Office provides guidance on international business restructures
The Australian Taxation Office (ATO) issued a draft ruling on business restructuring by multinational enterprises on 2 June 2010. The draft, which in its substance follows the OECD's Discussion Draft on Transfer Pricing Aspects of Business Restructurings (issued on 9 September 2021), is one of the first country-specific comments on business restructuring.
The draft ruling addresses the substantive issues related to business restructurings and provides a useful framework for documentation. In doing so, it also provides useful practical guidance on how to approach the analysis in the context of a supply chain restructure.
The draft ruling recognizes that comparability (and lack thereof) is a recurring issue when dealing with business restructuring: a number of pricing arrangements typically in place between related parties do not occur between unrelated parties, and related party business restructuring often have different characteristics than those between independent companies. Consequently, it will often be difficult to find comparable restructurings between unrelated parties for purposes of evaluating the arm's length nature of a related party restructure.
Therefore, the draft ruling places significant emphasis on the types of comparability measures, which may be relevant in establishing how third parties would have behaved under comparable circumstances.
The draft ruling proposes the following three-step process for reviewing transfer pricing in the context of a business restructure:
Step 1: Characterize the international dealings between the associated enterprises in the context of the taxpayer's business.
Step 2: Select the most appropriate transfer pricing methodology/ies.
Step 3: Apply the most appropriate method and determine an arm's length outcome.
Application to supply chain restructures
The case study in the draft ruling deals with the situation of a multinational enterprise with a full risk manufacturer in Australia (SubCo) that decides to restructure the group's manufacturing activity by centralizing such operations in a regional company located outside Australia (ForCo). Under the restructure, SubCo becomes a toll manufacturer for ForCo and SubCo ceases to have the rights to use relevant intellectual property. SubCo is paid a processing fee for its manufacturing services calculated on a "cost plus" basis.
Applying the three-step process outlined above, the ATO considers that the following questions are relevant:
- What are the true nature, terms and effect of the business restructuring arrangement and SubCo's dealings with associated enterprises (e.g. ForCo) under that arrangement?
- What are the business strategies underlying the business restructuring, including the expected benefits?
- Do the functional analyses of the business before and after the business restructuring accord with the changes and differences in the contractual terms?
- What consideration might be expected under an agreement between independent parties dealing at arm's length in comparable circumstances (e.g. in connection with a transfer of property, supply of a benefit, surrender of rights)?
- Would any options other than the business restructuring be realistically available to ForCo and SubCo at arm's length?
- Do the terms of the business restructuring make commercial sense for ForCo and SubCo given their relative bargaining positions at arm's length?
- Does the risk-reward trade-off involved in entering into the restructuring make commercial sense for SubCo in the circumstances?
- Does the allocation of risk under the restructured arrangements make commercial sense for ForCo and SubCo?
- Is the consideration payable and receivable under the postrestructuring (e.g. toll manufacturing) arrangement an arm's length amount?
An interesting point to note is that the draft ruling includes a general acceptance of the taxpayer's right to enter into business restructurings, without the business purpose of the restructuring being subject to separate review from Australian Taxation Office under the arm's length principle embodied in Australia's transfer pricing rules.
However, the draft ruling specifies that it does not address the application of Australia's general anti-avoidance provisions contained in Part IVA of the Income Tax Assessment Act 1936 (Part IVA). Broadly, Part IVA gives the Commissioner of Taxation the power to cancel a tax benefit (e.g. reduction in Australian assessable income) where the sole or dominant purpose of the relevant scheme is to obtain a tax benefit.
Australian Taxation Office has been increasingly active in this area recently and, as such, it is important that business restructurings have a commercial purpose. The draft ruling also does not address capital gains tax, permanent establishment or controlled foreign company issues from an Australian perspective. These are also important issues that need to be considered in the context of an international business restructure.
As a proactive step in addressing the tax risks associated with both historic and proposed business restructures, we recommend that taxpayers take advantage of the framework laid out in the draft ruling and address the areas highlighted (as necessary) to demonstrate comparability of their arrangements with how third parties would have behaved under comparable circumstances.